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Should central banks really be flexible?

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  • Grüner, Hans Peter

Abstract

In this paper I show that central bank flexibility may not be desirable when it encourages trade unions to behave more aggressively. The argument is based on a model where risk averse trade unions interact with a central bank. A flexible central bank stabilizes economic shocks and reduces output volatility. This enables trade unions to realize higher real wages without risking the unemployment of some insider workers. Risk averse insiders demand higher real wages, generate more inflation and more unemployment. The overall e ect on welfare may be negative. A conservative central bank instead increases output and employment on average but raises output volatility. The argument also sheds new light on the issue of optimum currency areas. Wage claims are lower and employment is higher in a currency union if national trade unions expect the central bank to do less to secure employment of insider workers in their country. JEL Classification: E52, E58

Suggested Citation

  • Grüner, Hans Peter, 2002. "Should central banks really be flexible?," Working Paper Series 188, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2002188
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    References listed on IDEAS

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    More about this item

    Keywords

    central bank credibility; central bank flexibility; Optimum Currency Area;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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